DEPOSIT INSURANCE, MARKET DISCIPLINE AND OFF-BALANCE SHEET BANKING RISK OF LARGE UNITED-STATES COMMERCIAL-BANKS

The 'market discipline' of off-balance sheet banking activities (OBSAs) is examined by employing contingent claims valuation techniques to derive implied asset variances from bank equity, and from risk-premia for bank subordinated debt. Specifically, implied asset variances have been calculated from market and on and off-balance sheet information using options pricing techniques. Theoretically these implied asset variances are better than equity variance or risk-premia in proxying bank risk because they capture portfolio effects as well as the non-linear nature of contingent claims model and the impact of closure rules. Empirical results suggest the existence of 'market discipline' of OBSAs. Market participants price these OBSAs as risk-reducing.